Draft legislation and an explanatory memorandum have been released to fundamentally change the way trusts are taxed.
At this stage, the legislation is very preliminary and much of the detail will be the subject of consultation and discussion. The policy intention supporting the legislation seems to be threefold:
1. To tax the persons who receive the economic benefits from a trust;
2. To permit streaming of capital gains and franked distributions, subject to the limitations mentioned below;
3. To close down blatant avoidance/evasion arising through receipt re classification.
The legislation will remove the taxation of a trust’s capital gains and franked distributions from Division 6 of the Income Tax Assessment Act 1936 and place into Subdivisions 115C and 207B of the Income Tax Assessment Act 1997.
Division 6 is not to be directly amended. The current division will continue to operate to assess beneficiaries on their share of a trust’s net income. Subdivisions 115C and 207B will be amended to operate so that they will tax a beneficiary on any share of a capital gain (Subdivision 115C) or franked distribution received by a Trustee (207B).
The taxation of capital gains and franked distributions will be effected on a type of hybrid basis. If beneficiaries have a specific entitlement to these types of distributions, they will be streamed to them on a quantum basis. This streaming will attach the tax attributes.
If there are no beneficiaries specifically entitled to these amounts then the income will be streamed to those beneficiaries proportionally (subject to the note about streaming of capital gains below).
If there are no beneficiaries with a specific entitlement to those amounts and no beneficiaries with any present entitlement to any income then the trustee will be taxed.
A new Division 5B will be introduced to adjust the Division 6 calculations brought about by the amendments to Subdivisions 115 and 207B. This will involve re calculating the net income of the trust estate and each beneficiary’s present entitlement basically to avoid double taxation on capital gains and franked distributions.
The legislation is attracting significant criticism in the taxation industry. Instead of having trust taxation dealt with in one specific Division of the Tax Act to operate exclusively the legislation will be spread over a series of Divisions and sub Divisions in different acts.
There are also anti avoidance rules to be introduced to operate where income exempt entities are used to attract a tax liability (which they don’t pay as they are income exempt) on a large percentage of the trusts net income(tax income). The rules will operate to tax the trustee on the tax which would otherwise have been payable if not so allocated to the income exempt entity.
The ability to stream franking credits and capital gains is subject to a few riders. The minutes streaming these types of income will have to be in place by 30 June each year. The trust deed must allow for streaming of franked distributions and capital gains (specifically). Additionally, the deeds must allow for streaming of a capital gain per asset. It is not permissible to stream a series of gains in one resolution. The trust must also allow for the recording of a “vested and indefeasible interest” in the trust property representing the capital gain and that interest must be recorded in the accounts of the trust.
Only directly related expenses can be deducted against a franked distribution or a capital gain and only the excess can be streamed. Again this capability should be in the deed.
If a trust is in a trust loss situation, it will not be able to pass through the imputation credits (but, it seems, capital gains can be) so there needs to be at least $1.00 of net income created in order to have the ability to stream through imputation credits.
If there are clients considering amendments to deeds or have trusts where gains or franked distributions are intended to be pass through the terms of the deed should be reviewed to determine if the deed needs amendment.
